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September 15, 2010

Gauging the Impact of Obama’s Proposed Tax Plan: Part II

Will extension of the middle class tax cuts prove a stimulus?

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President Barack Obama's tax proposal is changing the debate in Washington about corporate and personal taxes. Reaction is, so far, less partisan (though still very partisan) than much that has taken place in Washington since Obama took office in 2009.

Extending the cuts for the middle class--defined as the 98% of families earning less than $250,000 a year--would add $2.3 trillion to the Office of Management and Budget's (OMB) projected $10 trillion deficit in 2020, according to Tim Speiss, partner and chairman of EisnerAmper Personal Wealth Advisors. Extending the cuts to the 2% remaining, and highest-income, earners would add about another $1 trillion over 10 years, for a total deficit projection of $13.3 trillion.

The President proposed:

? Tax breaks for companies that create jobs in America rather than overseas

? A corporate write off for companies that invest in "plants and equipment" in 2011

? Additional infrastructure projects, and

? Making permanent the tax cuts (for those earning up to $250,000 a year (households)

Remarks by House Minority Leader John Boehner, R-Ohio, on Sunday, on "Face the Nation," were noted by media and politicians alike: "If the only option I have is to vote for those at 250 and below, of course I'm going to do that," he said, adding, "But I'm going to do everything I can to fight to make sure that we extend the current tax rates for all Americans."

On the middle-class tax cut extension, Speiss says, "right now, 98% of taxpayers are under the $250,000. You basically would be freezing those folks at a 33% rate; 35% rate; and 2% [of taxpayers making more than $250,000] could be subject to the much-higher 39.6% tax rate."

"If the bush tax cuts were extended [for everyone], it would add about $3.3 trillion to the federal deficit by 2020...right now, the deficit is expected to be $10 trillion by 2020. If you extended the Bush tax cut, you'd be increasing it by 30%," to $13.2% in 2020, Speiss says, using the OMB projections. "Even if the Obama $250,000 household tax plan comes into effect, you're still adding $2.3 trillion to the deficit," in 2020, making it $12.3 trillion. "It's only a 17% savings." To save the entire amount of $3.3 trillion from the 2020 deficit, Speiss says, Obama "would have to go deep into the middle class to do that."

The Hidden Tax on the Middle Class

"One of the biggest slights-of-hand," Speiss adds, "that nobody ever talks about," is the "Medicare, Social Security OASDI tax. That increases every year--and guess who pays that? Dollar for dollar it's the people under $250,000." Each year, Speiss notes, "the amount of income that is subject to the Medicare, Social Security OASDI tax increases...If you think about it, it is a supplemental income tax--it's on top of the income tax. And, by the way, there're no deductions against it."

Employers and employees each pay 7.5% of the first $106,800 of income for 2010, Speiss explains. The income subject to that tax could increase for 2011 by about 3%, to "about $110,000" and with the OASDI part another 50 basis points, "so saying you're giving the middle class a tax cut I could argue is disingenuous because if the Medicare, Social Security OASDI tax is always increasing about 3% a year, you're really not" giving a full tax cut.

"The president's proposal, increasing the rate to 39.6% for only those above $250,000 only reduces the forecasted deficit by 17% or 18%," per the estimated 2020 deficit, Speiss asserts. "If the Bush tax cuts were allowed to continue, it would cost another $3.3 trillion; if the president's plan were incepted, you're still looking at something around $2.3 trillion" added to the $10 trillion deficit estimate for 2020.

So the question also comes down to: Is it better--for job creation, the economy--to extend these tax cuts now, and pay down a higher deficit later, or to let these tax cuts expire now, for at least some of the population, and pay off a lower deficit later?

Using congressional and OMB's estimates, Speiss projects: "If we are in 2020 under a scenario of repealing the Bush tax cuts in full, the deficit would be roughly $10 trillion. But in that year, it's forecasted that Social Security, and Medicare and defense spending will be 106% of revenues...What happens if we let the Bush tax cuts stay in place? Now you've just gone to $13.2 trillion; you've bumped it by 30%; not a good answer. Tell me what would that number would be if we went with the President's plan? Now you're at $12.2 trillion--you're only saving about 18% compared to it would cost of you let the Bush plan stay in place. It's causing at least a 22% increase in the deficit," according to Speiss, when it's already projected that the budget will be under water when it comes to Social Security, Medicare and defense spending.

If a tax cut is extended for the middle class, will they spend what they are not paying in taxes? At EisnerAmper, Speiss says, they are studying whether "by going with the President's plan, is there a silver lining we're not considering? If you agree that it bumps up the deficit by another 22%--still not a great answer, could you say it's really not that bad because you're giving the middle class a tax cut and they now have that disposable income to spend on the economy--buy things? One could argue that that spending by the middle class will end up in the economy and act a s a stimulus and it is true, intuitively that is, that if you give a tax cut to the top earners--top 2%--they're going to invest, they're not going to spend it, and it's not going to make its way back into the economy."

Does the pick-up in the velocity of money by extension of the Bush cuts to the middle class result in a velocity of money jump that offsets the $2.3 trillion addition to the deficit in 2020? "I don't think anyone has stopped to put pen to paper and figure out, from a growth in the economy perspective, would the deficit shrink by either of those two cuts," says Speiss. Stay tuned.

Comments? Please send them to kmcbride@wealthmanagerweb.com. Kate McBride, AIF(R), is editor in chief of Wealth Managerand a member of The Committee for the Fiduciary Standard.